Preliminary Voting Data and the Need for A Clear Federal Approach: Red Oak Fund, LP v. Digirad (Part 3)
We are discussing Red Oak v. Digirad, a recent Delaware case where preliminary voting data played a significant role.
In that case, Red Oak, the 5th largest shareholder with over 5% of the shares, ran a competing slate of five directors. Red Oak's slate ultimately lost, with management receiving 40% and Red Oak receiving 34%. In the aftermath of the case, Red Oak filed suit under DGCL §225 challenging the election. Red Oak essentially alleged that the election was "unfair."
Red Oak made two claims with respect to interim voting data. The complaint alleged that the company made "improper and illegal disclosures about non-public interimproxy voting tabulations." In addition, Red Oak asserted that the election was unfair because the company knew that the preliminary voting data from Broadridge was inaccurate but did not disclose the inaccuracy to Red Oak or the other shareholders.
Section 225 permits a challenge to the "validity of any election." Where the court determines that an election was not valid, it has broad remedial authority and can order a rerun of the contest. See Portnoy v. Cryo-Cell Int’l, 940 A.2d 43, 82-83 (Del. Ch. 2008) (ordering a new election and apportioning the costs to the incumbent directors).
Section 225 does not define an "invalid" election. Sometimes it involves disputed elections that turn on things like the validity of a meeting. See Adlerstein v. Wertheimer, 2002 WL 205684 (Del.Ch.,2002) ("Here, the question is whether the meeting held on July 9 was a meeting of the board of directors or not."). Or the issue may be the validity of shares issued by the company. See In re Bigmar, Inc., 2002 WL 550469 (Del.Ch.,2002).
On other occasions, however, challeges involve something that amounts to allegations of the use of "unfair" tactics. See Portnoy, 940 A.2d 43 at 82-83 ("[T]he election was tainted by misbehavior by insiders who could not win an election simply using the traditionally powerful advantages afforded incumbents. Our law has no tolerance for unfair election tactics of this kind."). In general, these are expressed as a breach of fiduciary obligations. See Red Oak, C.A. No. 8559-VCN (Del. Ch. Oct. 23, 2013) ("Shareholders can challenge the election by alleging a breach of fiduciary duty by the board."). Often they are phrased as disclosure violations. See id. (companies have an obligation “to provide a balanced, truthful account of all matters disclosed in the communications with shareholders.”).
The court in Red Oak addressed whether a breach of fiduciary duty was a precondition for a challenge to the fairness of the election. The court declined to “fashion a bright-line rule that an election may be found invalid under Section 225 only if there is a breach of fiduciary duty.” In the absence of a breach of fiduciary duty, however, a shareholder seeking to invalidate an election “should offer more than mere speculation about the possible consequences of the perceived unfair election.”
In other words, the standard for showing unfairness would be higher in non-fiduciary duty cases. The approach provided a road map for future challenges. Given the difficulty in establishing a fiduciary duty violation, the court set out a basis for nonetheless overlooking instances of obvious unfairness. And, in fact, that is what occurred in this case.
The opinion and assorted filings in the case, including the transcript of the hearing, can be found at the DU Corporate Governance web site.